The Balassa-Samuelson hypothesis in the developed and developing countries revisited

- A new cointegration test for panel data with multiple heterogeneous unknown breaks is proposed.
- This test also captures the cross sectional dependence by incorporating non-stationary factors.
- Applying new test to the Balassa-Samuelson (BS) hypothesis shows the BS hypothesis holds only for developed economies.

This paper aims at examining the Balassa-Samuelson (BS) hypothesis in 20 developed and 20 developing countries, respectively. Given the cross-sectional dependence and structural breaks, we develop a new panel cointegration technique which allows for multiple heterogeneous unknown breaks and non-stationary factors. The empirical results show that the BS hypothesis holds in the developed countries, implying that higher productivity growth leads to a real appreciation, but they are cointegrated up to a number of cross-sectional unobserved stochastic trends as factors are non-stationary. However, we find little evidence to support the BS hypothesis in the developing countries and a further research is needed for the reason.